1. Sensitivity Analysis and Break-even Point. Ruckus Ltd is considering investing in a project at a cost of R3 000 000. The estimated economic and effective life of the project is 5 years. The company will use the straight-line method to depreciate the cost of the project over 5 years. The company estimates that sales will amount to 240 000 units per year at an estimated selling price of R40 per unit. The company expects to incur fixed overheads, excluding depreciation, of R300 000 per year and the variable cost per unit is R30. The company’s cost of capital is 11% and the corporate tax rate is 28%. The expected residual value of the project in 5 years’ time is expected to be zero.
(a) Use sensitivity analysis to determine how sensitive the NPV of the project would be if the selling price and sales volume respectively were reduced by 10%.
(b) Use scenario analysis to determine the best- and worst-case NPV if selling price, volume and variable cost can change by 10% either way from the expected values.
(c) Use break-even analysis to determine the minimum sales volume that the company is required to achieve in order to break-even in an Accounting sense and Economic (PV) sense respectively. How would the company use the PV breakeven volume calculated to account for the risk of the project? What accounts for the main difference between the two breakeven points calculated?